USD: Is Jackson Hole THAT Big Of A Deal?

Why EURO Rallied on Weak PMIs

The euro traded higher against the U.S. dollar Thursday despite a softer Eurozone PMI report. The currency pair has become deeply oversold according to CFTC positioning and a rebound is not unusual although we have to admit that we anticipated a bigger reaction to the weak Eurozone PMI report. For the region as a whole, economic activity slowed during the month of August with weakness seen in both the manufacturing and service sectors. However disappointments in other economic reports and dovishness from the ECB had investors bracing for a soft number and when they realized that economic activity in Germany beat expectations, it was the perfect excuse for a short covering driven relief rally. In the Eurozone's largest economy, manufacturing and service sector activity did not slow as much as anticipated and in France service sector activity actually accelerated. Of course, there is weakness in other parts of the region but as long as the two largest contributors to Eurozone GDP (Germany and France) are holding up well, the outlook for the Eurozone as a whole is less dismal. At the same time, the case for ECB easing becomes weaker if the German and French economy stabilizes but we don't think the PMI numbers are enough to convince the central bank that it is not necessary. The main focus is on Yellen Friday -- if she is hawkish, the EUR/USD could resume its slide but if she refrains from taking a more hawkish stance, it could accelerate the rebound in the currency because going into this week's event risks, short Eurozone positions were hovering near 20-month highs.

Sterling Hits 4-Month Lows on Weaker Retail Sales

The Bank of England's credibility continues to come into question with the latest U.K. retail sales report. Led by BoE Governor Carney, policymakers are signaling that rates could rise before wages increase but everything from Thursday's spending number to consumer prices and the Quarterly Inflation Report undermines the case for earlier tightening. The divergence between official rhetoric and economic data has left investors confused but based on the price action of sterling, they are giving more credence to the data. U.K. retail sales grew only 0.1% in the month of July, which was significantly weaker than the market's 0.4% forecast. On an annualized basis, this slowdown drove retail sales growth to an 8 month low of 2.6%. Although much of the disappointment was caused by weaker auto sales, excluding autos, demand still slowed to 3.4% from a downwardly revised 3.8% year over year. Of course, our readers should not be surprised by this softer release because we pointed out in Wednesday's note that the drop in demand and prices reported by the British Retail Consortium put the odds in favor of a downside surprise. As our colleague Boris Schlossberg pointed out "with both UK inflation and retail sales lower than forecast for the past three months, the data makes a mockery of yesterday's hawkish MPC minutes which saw two members vote for a rate hike. At present neither price pressures nor consumer demand pose any danger to inflation in the UK economy and therefore monetary tightening would be counter productive." However given how quickly and aggressively GBP/USD has fallen over the past month, we think the currency pair is due for a relief rally. The currency pair should find support at 1.65 and if Yellen's speech falls short on hawkishness, the GBP/USD could rebound back above 1.67.

CAD: Retail Sales and CPI on Friday

All three of the commodity currencies traded higher Thursday led by gains in the New Zealand dollar. What's interesting is that NZD/USD completely ignored weaker Chinese and New Zealand data as well as this morning's stronger U.S. economic reports. According to HSBC, manufacturing activity in China grew at a slower pace in the month of August. Since April, manufacturing activity has been growing at a steady pace and up until Thursday's release, other reports showed that China's economy was gaining momentum, raising hope that it would be a bright summer for Asia's largest economy and its trading partners. Unfortunately Thursday's report along with recent weakness in lending raises some concerns about this theory. Aside from the softer Chinese PMI report, the drop in New Zealand consumer confidence and credit card spending should have also weighed on NZD but instead the currency rebounded strongly versus the dollar on the back of short covering, a dynamic that also lifted the Australian dollar. The focus on Friday will be on the Canadian dollar with retail sales and consumer prices scheduled for release. Economists are looking for weaker numbers all around but after last week's hot employment report, we can't rule out an upside surprise.

JPY: PMI Manufacturing Index Hits 5-month Highs

Over the past 24 hours, the Japanese Yen traded lower against many major of the currencies but its gains were modest compared to Wednesday's rally because investors are trading cautiously ahead of Jackson Hole. With that in mind, economic data from Japan continues to improve, easing concerns about a loss of momentum in the economy. The manufacturing PMI index rose to a 5 month high of 52.4 from 50.5 with sizeable increase seen in new orders and exports. Earlier this month there were concerns that the rebound in June was beginning to fade but between the rise in exports and last night's higher manufacturing PMI index, there's hope that the economy is returning to normal conditions. The Nikkei rose 131 points overnight thanks to the stronger economic data and reports from one of Japan's largest newspapers that the government is considering setting aside 1 trillion yen for stimulus spending next fiscal year. If true, this decision would be motivated by Prime Minister Abe's attempts to shore up confidence. Additional fiscal and monetary stimulus is still on the table but whether or not the government moves forward with their plans hinges on the pace of recovery in the third quarter.

Written By: Kathy Lien